Income Tax Reform Taking Shape at State Level

While various groups call for tax reform at the federal level, where time spent preparing 2012 federal income tax returns is expected to cross 6 billion hours, the possibility of such reform happening is unlikely in the short term. But things are different at the state level.

In various states where Republicans control a majority in the state legislature and occupy the governor’s seat, the idea of reforming income tax is a real possibility. Several states—including Louisiana, North Carolina, and Kansas—are looking to simplify, reduce, and possibly eliminate state income tax. Revenues from the eliminated taxes would be replaced largely through an increase in sales tax.

“When it comes to getting pro-growth tax reform done this year, the only real opportunities are at the state level,” noted Patrick Gleason, director of state affairs for Americans for Tax Reform. Gleason’s group and others like it are looking to test tax reform options at the state level in hopes that they will prove workable and gain traction for federal income tax simplification at some point in the future.

But there are critics of the shift in taxes from a system based on income tax to one based on sales tax. Relying primarily on sales tax places more of the tax burden on the lower and middle class who spend more of their income on taxable items.

“Even if this is too radical, if it makes other radical schemes seem more reasonable, that’s worrisome,” noted Nicholas Johnson, an expert on state tax with the Center on Budget and Policy Priorities who is against a shift in state taxes.

Despite the criticisms, the political makeup in a number of states may soon make using states as a test bed for income tax reform a reality. In 37 of the 50 states, a single party controls both the legislature and governor’s seat. Of those, 25 are Republican controlled. This control makes state tax reform much more of a reality, as opposed to the split control by the Republican and Democrat parties at the federal level.

“We have no choice but to make change,” said Bob Rucho, a Republican senator in North Carolina. North Carolina is open to new options as they have historically seen higher than average unemployment rates and difficult-to-balance budgets.

Therefore, North Carolina is looking to do away with all state and corporate income tax. The state would likely both increase sales tax rates and impose taxes on services that are not taxed at present to replace the lost income tax revenue.

But supporters of state income tax reform are not blind to the criticisms. Rucho acknowledged that a change such as the one being considered by North Carolina would place more of the traditional sales tax burden on the poor and middle class. But Rucho believes the wealthy would pay their fair share as well through the increase in taxes on various services that are currently not taxed, such as accounting, food, and certain beauty and spa treatments.

Even so, such supporters have data showing that in general states with lower state income taxes perform better economically than do those states with higher state income taxes. Therefore, expect state tax reform to be a common topic throughout 2013.

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